PRESENTATION TO SACMA: FT CAWOOD READING BETWEEN THE LINES OF THE NEW SOUTH AFRICAN MINERAL AND PETROLEUM RESOURCES ROYALTY ACT A Technical Perspective on its Meaning
Structure Nature of the mining business Theory of mineral royalties The past system of royalties in South Africa Economic rents Formula fundamentals Main Royalty Act provisions What does the Royalty Act mean? Issues to look out for Fred Cawood 18 November 2010 2
Converting natural wealth into capital Taxable Income Surface development costs Marketing and Transport costs Operating costs Underground development costs Processing/Smelter costs Processing plant Smelter Marketable product Gross revenue Fred Cawood 18 November 2010 3
Theory of mineral royalties What are mineral royalties? Who should receive royalties? Why the controversy? What are the design considerations? What are the options? What are the alternatives? "Across the globe, no type of tax on mining causes as much controversy as a royalty tax" Otto et al (2006) Fred Cawood 18 November 2010 4
A case for royalties targeting rents Fred Cawood 18 November 2010 5
Historic mineral royalties in SA Before 1900: 1 2.5% of sales value Early 1900s: (Gold) lease consideration Late 1900s: Multiple schemes (negotiable) MPRDA (2002): State custodianship over minerals 2003/6 Royalty Bills: Specific rates on gross sales 2007 Royalty Bill: Formula based on NSR The Act: Dual formula on gross sales Fred Cawood 18 November 2010 6
Principles of Formula A formula is appropriate if we are after rents 1 st step Fix the royalty base 2 nd step - Fix the minimum rate (a) e.g. 1% 3 rd step - Fix the maximum rate (a+b) e.g. 3% 4 th step Use profitability (PBT) to slide the rate between (a) and (a+b) e.g. x-factor of gold formula Then (b) = rent premium, i.e. max 2% in example Y% = (a+b) the royalty rate Fred Cawood 18 November 2010 7
Structure of the Formula Y% = (a+b), where b = F acto X - r R ati o a chi e v e t o in t he c ure m axim n t u m y ear r ate x-ratio = PBT Sales revenue over the period Factor (F) based on principle that max profitability (100%) results in max rate (e.g. 3%) Solving for F in Formula, i.e. For a rate between 1 and 3%, For a rate between 1 and 5%, Y % = 1 + Y % = 1 + x% 50 x% 25 Fred Cawood 18 November 2010 8
The Royalty Act Money Bill for administration by SARS Promulgated in 2008 - effective from 1/3/2010 Imposes a royalty on the (first) transfer of minerals Mineral resource is as defined in Section 1 of the MPRDA - includes petroleum Transfer means disposal, export, consumption, theft, destruction or loss of a mineral resource Rollover relief available for transfers of going concerns that include minerals that have already been won, e.g. mineral resources in stockpiles - S9 Fred Cawood 18 November 2010 9
Royalty Act Formulae The two formulae target rents A royalty base of gross sales The minimum rate in both formulae = 0.5% The maximum rates (a+b) are 5 and 7% EBIT slide the rate between (a) and (a+b) The maximum rent premium (b) = 4.5 & 6.5% Y% = (a+b) Royalty amount for (12-month) assessment period = Rate (Y%) x Base (gross sales)
The scheme One of two formulae is used to calculate the rate This choice requires an assessment on refinement Both formulae are payable on a base of gross sales Refined rate Yr % = 0.5 + x/12.5 Unrefined rate Yu % = 0.5 + x/9.0 The reduced rate for refined products compensates for the additional cost of refinement Fred Cawood 18 November 2010 11
Classification according to definition Impacts on both base (sales value) and the royalty rate Refined minerals in Schedule 1 (Comprehensive beneficiation) Gold refined once processed to at least 99,5 per cent purity; Others are PGM 99,9%; Copper 99.0% Unrefined - Schedule 2 (Raw/Limited beneficiation) Coal interesting because of the provision for several grades It implies coal cannot be refined, but reduction of gross sales value is possible Others are Chrome (37% to 46%); Iron ore (61% to 64%) Dual Schedule Minerals (In both schedules e.g. platinum) Mineral viewed as refined if beneficiated to or above the refined condition; otherwise view as unrefined Also depends on the ratio of refined sales to total sales Fred Cawood 18 November 2010 12
Calculation of the Royalty Base Non-deductible expenses in blue Deductible expenses in red Fred Cawood 18 November 2010 13
Calculation of EBIT Earnings before Interest and Taxes As done for financial reporting purposes (but only earnings attributable to the winning and recovery of mineral resources are considered) EBIT for refined and unrefined minerals is not the same and the two EBITs are separately defined Complex, but cater for mine/industry specifics Fred Cawood 18 November 2010 14
An issue to watch out for Upward adjustment (Penalty) Below No adjustment Downward adjustment (Incentive) Above Gross sales adjustments Fred Cawood 18 November 2010 15
Another issue to watch out for Impact varies under different EBITs Fred Cawood 18 November 2010 16
Impact on reporting The decision on, and justification for, which in situ resource grade to use for the purpose of adjustment Technical sign-off(s) on the quantity and quality for the range of mineral products e.g. coal mines Technical and accounting input to the adjustments to revenue for products outside the specified conditions Mine-specific definitions and methods for calculating gross sales, EBIT and the royalty amount Adjustment of transfer pricing protocols for valuation of non-arm s-length gross sales values Auditor s alignment of the royalty parameters with financial reporting standards Fred Cawood 18 November 2010 17
What does the Act mean to the State? Mineral and petroleum taxes account for about 17% of total corporate taxes, while its contribution is about 8% Expect about a 7% rise in mining s contribution to company taxes and a 50% rise in the tax bill in boom times assuming taxes from other industries remain constant Mining WILL play an even role in future because of the Act Fred Cawood 18 November 2010 18
What does the Act mean to Industry? Impact is difficult to predict The wide range in profitability is indicative of the cyclic nature and need to spend capital The gaps between the lines show that the impact is significant during times of high profitability, while less significant during times of low profitability Fred Cawood 18 November 2010 19
THANK YOU ANY QUESTIONS? News flash from Wits Mining Graduation evening is 7 November 60 of the 74 final year students passed this year 40 are male and 20 female 20
Converting ore body into a valuable product, which is exchanged for cash Finance costs Reinvestment MINERAL ROYALTY Input costs Labour Goods Services Turnover taxes Income Tax Regulatory costs Investor s NPV Dividends Tax Fred Cawood 18 November 2010 21
Understanding mineral rents Mineral Price Px P Mine A Mines A + B Mines A - C Mine A - D Mines A - E (Mine E is Marginal) Mine F (Loss) Mineral Quantity Qx Q Fred Cawood 18 November 2010 22
Not all mines are equal Mineral Price Px P Profitable mines (A-D) Mine A Mine B Mine C Mine D Mine E (Marginal) Mine F (Loss) Mineral Quantity Qx Q Fred Cawood 18 November 2010 23
Elastic markets can respond quickly Mineral Price Px P2 Historical marginal mines become profitable (A-F) Mine A Mine B Mine C Mine D Mine E (Marginal) Mineral Quantity Qx Q2 Q Fred Cawood 18 November 2010 24
However, mine supply is inelastic... Mineral Price Px P2 Py P Mine A Mine B Mine C Mine D Mine E (Marginal) Mineral Quantity Qx Q2 Q Fred Cawood 18 November 2010 25
But... rents can just as easily evaporate Mineral Price Pn Px P Mine A Mine B Mine C (Now marginal) Mine D (Loss) Mine E (Historically Marginal) Mine F (Loss) Mineral Quantity Qx Q Fred Cawood 18 November 2010 26
The intent of the Formula Fred Cawood 18 November 2010 27